My business school professor: Wrong! To maximize shareholder value. You could please customers by giving your product away for free, but that wouldn’t please your shareholders.

Me: With all due respect, it wouldn’t please your customers for very long if you go out of business by giving away your product for free — especially if they value your product, now would it?

My business school professor: [This-discussion-is-over glare] [Proceed to explain why maximizing shareholder value is the key goal of a firm].

I never bought the ‘maximize shareholder value’ credo, or at least the moronic behavior it led to. I do believe it is the manager’s job to maximize shareholder value, but I never believed that was the goal. Rather, it is a result of pleasing customers.

I’ve seen too many short-sighted decisions come from the ‘maximize shareholder value’ mantra because the customer was left out of the equation.

Although Jack Welch was seen during his tenure as CEO of GE as the heroic exemplar of maximizing shareholder value, he came to be one of its strongest critics. On March 12, 2009, he gave an interview with Francesco Guerrera of the Financial Times and said, “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy… your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal. … Short-term profits should be allied with an increase in the long-term value of a company.”

I remember one example of this short-sighted focus on shareholder value when I as an engineer for a utility company. One of our big industrial customers — infected by the shareholder value mantra — approached us seeking to buy the electrical facilities at their plant. We delivered power to them at the low voltage they needed to run their equipment. We also had special switchgear at their site — that we owned — to provide the volume and reliability they needed. We charged them extra for this enhanced service.

They computed the simple math of the cash outlay to buy the equipment from us, the fees that would save them and the cost they thought it would take to maintain the equipment. I saw their analysis. On paper it looked like a good investment, one that would add to their shareholder value by reducing costs and increasing profits.

But, their experience was different. They quickly learned that the higher fees they use to pay us included something they didn’t have — expertise and opportunity cost. They realized that trying to figure out how to maintain electrical switchgear took time away producing the products they made for their customers.

They first hired us back to maintain the equipment and then eventually sold the equipment back to us and ‘got out of the business of maintaining electrical switchgear’ so they could again focus on delivering value for their customers.

We spent a fair amount of time in b-school talking about aligning manager interests with shareholder interests. It seems like the simplest way to do that is to have the managers be owners.

I wonder how many executives would choose to stay in their jobs if their salaries were dropped to $100,000 and the Board of Directors told them if they want to make money, then they should invest their own funds in the business and they will make money when shareholders make money.

Now, I realize executive pay is a free market and a good manager is worth a good salary and much of CEO pay is really the cost cover the legal risk of being an executive, but still, I think it’s an interesting thought experiment.

It’s a thought experiment modeled after Warren Buffet, who takes a salary of $100,000 for running Berkshire Hathaway, but has become a billionaire by owning a fair size chunk of that company.

If this became the norm in executive pay, I would guess that we would see a different group of people occupying the executive suites. Speaking of executive suites, I’d bet those suites would not be as well-appointed if the managers were owners.

Now, some folks might argue that executives often do have significant portions of their pay and bonuses tied to the stock performance. On the surface, that seems like a logical way to align the interests. But, experience has proven otherwise and the explanations are simple.

For example, managers with stock options, stock grants and stocks bought with non-recourse loans from the company help align executive interests with shareholders on the upside, but not the down side. Managers personally lose nothing, except potential profits, for taking big risks to try to move the stock price up.

Not only that, but executives often have severance agreements that reward them relatively handsomely for getting fired. So, the only downside to taking big risks is the executive’s ego.

The role of a creative leader is not to have all the ideas; it’s to create a culture where everyone can have ideas and feel that they’re valued. So it’s much more about creating climates. I think it’s a big shift for a lot of people.

I found the rest of the article somewhat vague. But I agree with this paragraph. Leaders of many organizations — government, companies, non-profits, clubs, charity events, etc. — could benefit from learning this.

Leaders often mistakenly believe their role is to come up with the new ideas to move their organization forward. They believe they need to chart a course. The followers don’t help, they also often believe this. It’s tempting to try to be the hero and to expect leaders to try to be heroes.

But it is also ineffective and risky. Certainly, it appears to have worked in a few circumstances. Steve Jobs pops to mind. But, I would be willing to bet that there are some unsung heroes even in his success stories.

It’s not ineffective and risky for leaders to come up with new ideas. It’s ineffective and risky when its only their ideas that get attention and organizational resources for several reasons.

Why? Because so many successes are the result of accidental experiments. Somebody’s track record isn’t necessarily a good predictor of their future success. The folks who do have a good number of successes probably have more trials and failures as well.

The reason why this leadership style isn’t prevalent is because few people believe this.

I think back to this and this post on Felix Dennis, publisher and billionaire. He has come up with a number profitable ideas in his day. But, the true secret to his success is how he has harnessed the ideas of others.

Here are a few final bookmarks from Felix Dennis’s How to Get Rich. I highly recommend the book, even if you don’t wish to get rich. It’s easy to read and contains a lot of wisdom that can help you in various parts of your life.

On luck, first-mover myth and tunnel vision (p. 142):

The only truth about luck, good or bad, is that it will change. The law of averages virtually guarantees it. And here, I think, is one difference that separates me from my “unlucky” friend, whom I shall call Albert.

By moving so adroitly and so swiftly from one thing to the next, Albert does not place himself in the way of luck. He is too much in love with the green, green grass just over the hill.

Then again, Albert is more intelligent than I am. But there is a downside to all this intelligence and imagination. He thinks a little too much before he acts. He weighs the options too carefully. He is capable of imagining defeat.

So while he is clever enough to want to minimize his risk by switching to yet another new and uncontested marketplace, he leads himself into uncertainty. And into error.

Uncontested markets are usually uncontested for a reason. Nature abhors a vacuum and if no one else is contesting a market, it may well be that no such market exists.

There are other differences between Albert and me. He is a great believer in partnering and share options and employee profit participation. …in Albert’s case, this division of the spoils is undertaken in the minutest detail, long before there are any profits whatever to share. Albert believes they encourage his coworkers. But such arrangements are immensely time-consuming and a distraction from the tunnel vision necessary to become rich in the first place.

On negotiation and politics (p. 149):

If you are overly fond of haggling, my advice is that you quit thinking about making money the old-fashioned way and consider becoming a politician instead. That way you can rob and plunder your fellow citizens year after year without risking your own financial security or capital–you bastard. (By the way, please get used to people thinking of you as a bastard. After all, it’s what nearly everyone thinks of politicians, except themselves).

On management (p. 150):

All great companies, all well-run organizations, need great managers and great staff. That much, at least, is pretty obvious. You forget it at your peril.

But the acquisition of of managers who can bring a sense of mission to even mundane tasks, who can identify potential candidates, nurture late bloomers, fire dullards and whiners and adapt to changing circumstances–that searching, identifying and nurturing is not about negotiating. It’s about setting an example of true meritocracy in a company where nepotism hasn’t a chance and where those who wish to succeed are given every opportunity and encouragement to do so.

I believe one secret of good leadership is rewarding and punishing the right outputs, or results. Bad leaders tend to fixate on inputs and/or the wrong results.

For example, a business owner complained to me about one of his associates. His gripes were personal preferences. He didn’t like the way his associate did this or that. He asked my opinion. Rather than giving it based on my five minutes with the guy (which I didn’t think would be fair to anyone), I simply asked how are his numbers? I thought it would be good to re-focus the owner on the results. I could read it in the owner’s eyes, good question, I hadn’t thought of that.

My advice to folks who desire to be a successful leader is to grow accustomed and adept at asking and answering …and that resulted in what?

The next step is making sure you hold folks accountable to the right results.

A business professor of mine once told the class his story about bonus structures he experimented with when he owned and operated sandwich shops.

First, he wanted to grow revenue so he tied managers’ bonus to revenue growth. That resulted in high food and staff costs as managers tried to attract business with over portioned sandwiches and always had more than enough staff on hand to handle unexpected rushes. While customer traffic was good, profits suffered because of high costs.

Next, he tied rewards to costs to gets costs under control. That resulted in long lines, under portioned sandwiches and customer complaints as managers tightly controlled staffing and portions to meet the cost targets. Customer traffic slipped with service and product quality and profits suffered.

In both cases, he felt the store managers didn’t pay enough attention to the cleanliness of the store. The owner was spent late hours scrubbing trash can lids and cleaning windows to meet his standards.

Finally, he tried a combination plan. First, he came up with a 70 point inspection checklist that he would use to rate the cleanliness of things like the trash can lids, bathrooms, tables, floors, counters and doors. He told his managers that he would inspect the stores any time, day or night, and to be eligible for a bonus store the store had to score 69 out of 70.

If the manager passed the inspections, then he or she would be eligible for a bonus that was based on year-over-year revenue and profit growth for the month. Further, for each month that staff costs were less than a certain percent of sales, staff would receive a bonus making up the difference.

He was pleased with the results. He said managing the operation became as simple as conducting the inspections.

He no longer spent late nights scrubbing trash can lids. Managers and staff found ways to increase sales and control costs, rather than focusing on one at the expense of the other.

It took some experimentation, but he seemed to have have found the right outputs to reward.

This is another post in my continuing series of good questions to ask managers you may be hiring to run a business. These come in handy whether you are sitting on a Board of Directors for a business and need to interview executive candidates, running a piece of business or a small shop.

The Question:

We’re strangers sitting next to each other on an airplane. How would you convince me to give this business a try?

This question gets to the heart of whether this candidate can effectively sell your business.

In the business world, I’ve witnessed many problems that stem from having managers in place that cannot sell the business. They don’t understand the business’s value proposition, don’t know or seem to care why clients voluntarily part with their money to buy the products or services.

Having such a manager is bad news. It will very likely destroy value.

What’s even worse is when the manager would not choose to use the product or service if they were not employed by it. The tendency of such a manager is to remake the business to suit their own preference as customer, while ignoring or changing what it is about the business that makes it valuable to its existing customers. This also destroys value.